##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (Mark One)  þ
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the Quarterly Period ended September 30, 2004  o
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from ___________ to ___________ Commission file number: 000-19580 T-3 ENERGY SERVICES, INC.  Delaware
(State or Other Jurisdiction
of Incorporation or Organization)
    
    76-0697390
(IRS Employer
Identification No.)
 13111 Northwest Freeway, Suite 500, Houston, Texas
(Address of Principal Executive Offices)
    
    77040
(Zip Code)
 (Registrants telephone number, including area code): (713) 996-4110 Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes þ No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes o No þ At November 3, 2004, the registrant had 10,581,986 shares of common stock
outstanding.




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TABLE OF CONTENTS FORM 10-Q PART ICertification of CEO Pursuant to Rule 13a-14(a)Certification of CFO Pursuant to Rule 13a-14(a)Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  Item
    
    
    
    Page1.
    
    Financial StatementsConsolidated Balance Sheets as of September 30, 2004 and
December 31, 2003
    
    
    1Consolidated Statements of Operations for the Three and Nine Months Ended
September 30, 2004 and 2003
    
    
    2Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2004 and 2003
    
    
    3Notes to Consolidated Financial Statements
    
    
    42.
    
    Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    113.
    
    Quantitative and Qualitative Disclosures about Market Risks
    
    
    214.
    
    Controls and Procedures
    
    
    21PART II1.
    
    Legal Proceedings
    
    
    222.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    223.
    
    Defaults Upon Senior Securities
    
    
    224.
    
    Submission of Matters to a Vote of Security Holders
    
    
    225.
    
    Other Information
    
    
    226.
    
    Exhibits
    
    
    22
 i




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T-3 ENERGY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands except for share amounts) September 30,
    
    December 31,2004
    
    2003(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    2,113
    
    
    $
    17Restricted cash
    
    
    
    
    
    
    102Accounts receivable  trade, net
    
    
    18,092
    
    
    
    19,335Inventories
    
    
    17,472
    
    
    
    12,083Notes receivable, current portion
    
    
    1,260
    
    
    
    1,462Deferred income taxes
    
    
    3,710
    
    
    
    2,613Prepaids and other current assets
    
    
    4,652
    
    
    
    4,159Current assets of discontinued operations
    
    
    
    
    
    
    13,630Assets held for sale
    
    
    
    
    
    
    119Total current assets
    
    
    47,299
    
    
    
    53,520Property and equipment, net
    
    
    18,841
    
    
    
    20,240Notes receivable, less current portion
    
    
    376
    
    
    
    370Goodwill, net
    
    
    68,062
    
    
    
    68,726Other intangible assets, net
    
    
    1,735
    
    
    
    2,228Other assets
    
    
    482
    
    
    
    453Total assets
    
    $
    136,795
    
    
    $
    145,537LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable  trade
    
    $
    8,396
    
    
    $
    7,822Accrued expenses and other
    
    
    9,523
    
    
    
    6,620Current maturities of long-term debt
    
    
    43
    
    
    
    10,093Current liabilities of discontinued operations
    
    
    
    
    
    
    1,406Total current liabilities
    
    
    17,962
    
    
    
    25,941Long-term debt, less current maturities
    
    
    12,047
    
    
    
    14,263Other long-term liabilities
    
    
    142
    
    
    
    177Deferred income taxes
    
    
    4,186
    
    
    
    2,790Commitments and contingenciesStockholders equity:Preferred stock, $.001 par value, 25,000,000 shares
authorized, no shares issued or outstanding
    
    
    
    
    
    
    Common stock, $.001 par value, 50,000,000 shares authorized,
10,581,986 shares issued and outstanding at September 30, 2004
and December 31, 2003
    
    
    11
    
    
    
    11Warrants, 517,862 issued and outstanding at
September 30, 2004 and December 31, 2003
    
    
    853
    
    
    
    853Additional paid-in capital
    
    
    122,960
    
    
    
    122,954Retained deficit
    
    
    (21,366
    )
    
    
    (21,452
    )Total stockholders equity
    
    
    102,458
    
    
    
    102,366Total liabilities and stockholders equity
    
    $
    136,795
    
    
    $
    145,537
 The accompanying notes are an integral part of these consolidated financial statements. 1




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T-3 ENERGY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands except per share amounts) Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenues:Products
    
    $
    22,033
    
    
    $
    24,417
    
    
    $
    61,897
    
    
    $
    63,144Services
    
    
    5,968
    
    
    
    3,849
    
    
    
    17,633
    
    
    
    18,95228,001
    
    
    
    28,266
    
    
    
    79,530
    
    
    
    82,096Cost of revenues:Products
    
    
    15,678
    
    
    
    17,440
    
    
    
    44,065
    
    
    
    44,535Services
    
    
    3,771
    
    
    
    2,653
    
    
    
    11,290
    
    
    
    12,54819,449
    
    
    
    20,093
    
    
    
    55,355
    
    
    
    57,083Gross profit
    
    
    8,552
    
    
    
    8,173
    
    
    
    24,175
    
    
    
    25,013Operating expenses
    
    
    5,752
    
    
    
    6,350
    
    
    
    17,615
    
    
    
    18,974Income from operations
    
    
    2,800
    
    
    
    1,823
    
    
    
    6,560
    
    
    
    6,039Interest expense
    
    
    548
    
    
    
    825
    
    
    
    1,884
    
    
    
    2,377Interest income
    
    
    57
    
    
    
    63
    
    
    
    170
    
    
    
    181Write-down of acquired note receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,703Other (income) expense, net
    
    
    104
    
    
    
    354
    
    
    
    162
    
    
    
    339Income from continuing operations before
provision for income taxes
    
    
    2,205
    
    
    
    707
    
    
    
    4,684
    
    
    
    1,801Provision for income taxes
    
    
    912
    
    
    
    334
    
    
    
    1,869
    
    
    
    780Income from continuing operations
    
    
    1,293
    
    
    
    373
    
    
    
    2,815
    
    
    
    1,021Loss from discontinued operations, net of tax
    
    
    (164
    )
    
    
    (257
    )
    
    
    (2,729
    )
    
    
    (463
    )Net income
    
    $
    1,129
    
    
    $
    116
    
    
    $
    86
    
    
    $
    558Basic earnings (loss) per common share:Continuing operations
    
    $
    .12
    
    
    $
    .04
    
    
    $
    .27
    
    
    $
    .10Discontinued operations
    
    $
    (.01
    )
    
    $
    (.03
    )
    
    $
    (.26
    )
    
    $
    (.05
    )Net income per common share
    
    $
    .11
    
    
    $
    .01
    
    
    $
    .01
    
    
    $
    .05Diluted earnings (loss) per common share:Continuing operations
    
    $
    .12
    
    
    $
    .04
    
    
    $
    .27
    
    
    $
    .10Discontinued operations
    
    $
    (.01
    )
    
    $
    (.03
    )
    
    $
    (.26
    )
    
    $
    (.05
    )Net income per common share
    
    $
    .11
    
    
    $
    .01
    
    
    $
    .01
    
    
    $
    .05Weighted average common shares outstanding:Basic
    
    
    10,582
    
    
    
    10,582
    
    
    
    10,582
    
    
    
    10,582Diluted
    
    
    10,582
    
    
    
    10,582
    
    
    
    10,584
    
    
    
    10,584
 The accompanying notes are an integral part of these consolidated financial statements. 2




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T-3 ENERGY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands) Nine Months EndedSeptember 30,2004
    
    2003Cash flows from operating activities:Net income
    
    $
    86
    
    
    $
    558Adjustments to reconcile net income to net cash
provided by operating activities:Loss from discontinued operations, net of tax
    
    
    2,729
    
    
    
    463Bad debt expense
    
    
    391
    
    
    
    175Depreciation and amortization
    
    
    1,886
    
    
    
    2,296Amortization of deferred loan costs
    
    
    767
    
    
    
    747Loss on sale of assets
    
    
    208
    
    
    
    Write-down of acquired note receivable
    
    
    
    
    
    
    1,703Write-down of other intangible assets, net
    
    
    150
    
    
    
    Deferred taxes
    
    
    525
    
    
    
    (245
    )Amortization of stock compensation
    
    
    6
    
    
    
    34Changes in assets and liabilities:Accounts receivable  trade
    
    
    919
    
    
    
    (2,170
    )Inventories, net
    
    
    (5,389
    )
    
    
    (614
    )Prepaids and other current assets
    
    
    2,108
    
    
    
    2,761Notes receivable
    
    
    196
    
    
    
    265Other assets
    
    
    (39
    )
    
    
    170Accounts payable  trade
    
    
    574
    
    
    
    (1,843
    )Accrued expenses and other
    
    
    (2
    )
    
    
    778Assets held for sale, net
    
    
    119
    
    
    
    13Net cash provided by operating activities
    
    
    5,234
    
    
    
    5,091Cash flows from investing activities:Purchases of property and equipment
    
    
    (1,889
    )
    
    
    (1,038
    )Proceeds from sales of property and equipment
    
    
    1,023
    
    
    
    79Net cash used in investing activities
    
    
    (866
    )
    
    
    (959
    )Cash flows from financing activities:Proceeds from long-term debt
    
    
    
    
    
    
    Payments on long-term debt
    
    
    (12,266
    )
    
    
    (4,069
    )Debt financing costs
    
    
    (320
    )
    
    
    (220
    )Net cash used in financing activities
    
    
    (12,586
    )
    
    
    (4,289
    )Net cash provided by (used in) discontinued operations
    
    
    10,212
    
    
    
    (667
    )Net decrease in restricted cash
    
    
    102
    
    
    
    Net increase (decrease) in cash and cash equivalents
    
    
    2,096
    
    
    
    (824
    )Cash and cash equivalents, beginning of year
    
    
    17
    
    
    
    854Cash and cash equivalents, end of period
    
    $
    2,113
    
    
    $
    30
 The accompanying notes are an integral part of these consolidated financial statements. 3




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T-3 ENERGY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial
statements. In the opinion of management, all adjustments (consisting of
normal recurring adjustments) considered necessary for fair presentation have
been included. These financial statements include the accounts of T-3 Energy
Services, Inc. and its subsidiaries (T-3 or the Company). All significant
intercompany balances and transactions have been eliminated in consolidation.
Operating results for the three and nine months ended September 30, 2004, are
not necessarily indicative of the results that may be expected for the year
ended December 31, 2004. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Companys Annual
Report on Form 10-K for the year ended December 31, 2003. Certain
reclassifications were made to previously reported amounts in the consolidated
financial statements and notes to reflect discontinued operations and to make
them consistent with the current presentation format. Stock-Based Compensation At September 30, 2004, the Company had a stock option plan, which is
described more fully in the Companys Annual Report on Form 10-K for the year
ended December 31, 2003. The Company accounts for that plan under the
recognition and measurement principles of Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees and related
interpretations. No stock-based employee compensation cost is reflected in net
income, as all options granted under those plans had an exercise price equal to
the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and earnings per common
share if the Company had applied the fair value recognition provisions of SFAS
No. 123, Accounting for Stock-Based Compensation to stock-based employee
plans (dollars in thousands, except per share data): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income, as reported
    
    $
    1,129
    
    
    $
    116
    
    
    $
    86
    
    
    $
    558Total stock-based
employee compensation
expense determined
under fair value
method for all awards,
net of related tax
effects
    
    
    (27
    )
    
    
    (75
    )
    
    
    (83
    )
    
    
    (230
    )Net income, as adjusted
    
    $
    1,102
    
    
    $
    41
    
    
    $
    3
    
    
    $
    328Basic EPS:As reported
    
    $
    .11
    
    
    $
    .01
    
    
    $
    .01
    
    
    $
    .05As adjusted
    
    $
    .10
    
    
    $
    .00
    
    
    $
    .00
    
    
    $
    .03Diluted EPS:As reported
    
    $
    .11
    
    
    $
    .01
    
    
    $
    .01
    
    
    $
    .05As adjusted
    
    $
    .10
    
    
    $
    .00
    
    
    $
    .00
    
    
    $
    .03
 For the purpose of estimating the fair value disclosures above, the fair
value of each stock option has been estimated on the grant date with a
Black-Scholes option pricing model. The following assumptions for the three
months ended September 30, 2004 and 2003 were computed on a weighted average
basis: risk-free interest rate of 4.12% and 3.87%, respectively, expected
volatility of 42.44% and 43.21%, respectively, expected life of 4 years for
each period and no expected dividends. The following assumptions for the nine
months ended 4




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September 30, 2004 and 2003 were computed on a weighted average basis:
risk-free interest rate of 4.12% and 3.80%, respectively, expected volatility
of 42.44% and 43.44%, respectively, expected life of 4 years for each period
and no expected dividends. The effects of applying SFAS No. 123 may not be
indicative of future amounts since additional future awards are anticipated and
the estimation of values involves subjective assumptions that may vary
materially as a result of actual events. Write-down of Acquired Note Receivable Prior to the merger of the Company and Industrial Holdings, Inc. (IHI),
IHI sold a subsidiary, Beaird Industries Inc. (Beaird), to an entity
controlled by Don Carlin and Robert Cone, and IHI received a $3.5 million
promissory note from the former subsidiary as the purchase price. Mr. Carlin
is a former director, and Mr. Cone is a former executive officer and director
of the Company. During the first quarter of 2003, the Company was informed by
Beaird of its inability to make timely interest payments and that efforts to
restructure its debt obligations had to date been unsuccessful. Accordingly,
the Company wrote-down approximately 50% of the note, because management
believed that the notes net realizable value was approximately $1.7 million.
In the fourth quarter of 2003, the Company learned that efforts to refinance
Beaird had failed, and management determined that the note was uncollectible
and wrote-off the remaining balance of the note. The first quarter of 2003
write-down amount appears in the Statement of Operations for the nine months
ended September 30, 2003 under the caption Write-down of acquired note
receivable. 2. DISCONTINUED OPERATIONS During the fourth quarter of 2003, the Company committed to a formal plan
to sell certain non-core assets within its Products segment. The sale of these
assets was consummated in February 2004. The Company received $7.4 million in
cash at closing that was immediately used to pay down the term loan under its
senior credit facility. The assets sold comprised substantially all of the
assets of LSS  Lone Star  Houston Inc., Bolt Manufacturing Co., Inc. (d/b/a
Walker Bolt Manufacturing Company) and WHIR Acquisition, Inc. (d/b/a Ameritech
Manufacturing) (collectively, the Fastener Businesses). The Fastener
Businesses primarily manufacture and distribute a broad line of standard and
metric fasteners, in addition to manufacturing specialty fasteners and parts in
small quantities for the commercial and aerospace industries, as well as the
military. At December 31, 2003, these assets constituted a business and thus
were classified as discontinued operations. Accordingly, the Fastener
Businesses results of operations for 2004 and 2003 have been reported as
discontinued operations. See Note 2 to the Companys consolidated financials
statements included in the Companys Annual Report on Form 10-K for the year
ended December 31, 2003 for additional information. During the second quarter of 2004, the Company committed to a formal plan
to sell substantially all of the remaining assets within its Products segment,
except for certain assets related to the Companys custom coatings business,
along with certain assets within its Pressure Control segment. A portion of
the remaining Products segment assets were sold during May and June 2004 and
qualified as discontinued operations. The Company received $1.0 million and
$0.4 million, respectively, in cash at the closings. The assets sold
comprised substantially all of the assets of one of the two operating divisions
of Moores Pump & Services, Inc., known as Moores Machine Shop and TPS Total
Power Systems, Inc. (TPS). Moores Machine Shop primarily is engaged in the
manufacture and production of downhole and completion products and equipment.
TPS distributes new electric motors; provides complete rewinding, repair and
rebuilding for used AC/DC electric motors and generators; and repairs and
manufactures used flood pumps and waste disposal pumps for governmental
entities in Louisiana and Texas. The remaining assets of Moores Pump &
Services, Inc. (Moores Pump) and Control Products of Louisiana, Inc. (CPL)
were sold during the third quarter of 2004 for $0.6 million and $0.5 million,
respectively. These assets constituted businesses and were classified as
discontinued operations. Moores Pump is a pump distribution and
remanufacturing business. CPL primarily repairs and manufactures control
valves and related equipment. Accordingly, the results of operations of Moores
Machine Shop, TPS, Moores Pump and CPL for 2004 and 2003 have been reported as
discontinued operations in this Form 10-Q. T-3 assessed the realizability of the Companys recorded goodwill and
other intangibles at December 31, 2003. As a result, T-3 recorded a goodwill
impairment charge during the fourth quarter of 2003 for the Products 5




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Segment operations. At June 30, 2004, Pressure Control goodwill was allocated
based on the relative fair values of the portion of the reporting unit being
disposed and the portion of the reporting unit remaining. This resulted in a
goodwill impairment charge of $0.3 million during the second quarter of 2004,
related to the assets being sold within the Companys Pressure Control segment.
In addition to the goodwill impairment charge, the Company recorded a $0.2
million charge to other intangible assets and a $2.4 million charge to tangible
assets related to the Products and Pressure Control dispositions during the
second quarter of 2004. Accordingly, these impairment charges have been
reported as discontinued operations. T-3 reassessed the realizability of the
Pressure Control segments recorded goodwill and other intangibles at June 30,
2004 in accordance with SFAS No. 142 and no further impairment was recorded. Net revenues from discontinued operations for the three months ended
September 30, 2004 and 2003 were $0.3 million and $9.0 million, respectively.
For the same periods, loss before benefit for income taxes was $0.2 million and
$0.4 million, respectively. Net revenues from discontinued operations for
the nine months ended September 30, 2004 and 2003 were $9.1 million and $28.5
million, respectively. For the same periods, loss before benefit for income
taxes was $3.9 million and $0.7 million, respectively. 3. ASSETS HELD FOR SALE During the second quarter of 2004, the Company also sold certain assets of
the spray weld division of O&M Equipment, L.P. for cash of $0.3 million. These
assets did not constitute a business; however, they did qualify as assets held
for sale. Accordingly, they are presented as such on the December 31, 2003
consolidated balance sheet. The disposition of these assets resulted in a loss
on sale of $50,000, which included a $150,000 write-down of other intangible
assets. The results of operations are classified in income from continuing
operations for 2004 and 2003. 4. INVENTORIES Inventories consist of the following (dollars in thousands): September 30,
    
    December 31,2004
    
    2003Raw materials
    
    $
    3,144
    
    
    $
    2,250Work in process
    
    
    3,365
    
    
    
    2,143Finished goods and component parts
    
    
    10,963
    
    
    
    7,690$
    17,472
    
    
    $
    12,083
 5. DEBT On September 30, 2004, the Company amended and restated its senior credit
facility and subordinated term loan (as defined). The amended and restated
senior credit facility provides for a $50 million revolving line of credit that
the Company can increase by up to $25 million (not to exceed a total commitment
of $75 million) and matures September 30, 2007. The senior credit facility
consists of a revolving credit facility that includes a swing line subfacility
up to $5 million and a letter of credit subfacility up to $5 million. The
Company has capitalized $0.4 million of deferred loan costs in connection with
the amended and restated senior credit facility. The Company will use the
proceeds from any advances made pursuant to the senior credit facility to
refinance indebtedness, for working capital purposes, capital expenditures, and
to fund acquisitions. The applicable interest rate of the senior credit
facility is governed by the Companys leverage ratio and ranges from prime plus
0.75% or LIBOR plus 1.75% to prime plus 2.00% or LIBOR plus 3.00%. The Company
is required to prepay the senior credit facility under certain circumstances
with the net cash proceeds of certain asset sales, insurance proceeds and
equity issuances subject to certain conditions. The senior credit facility
provides, among other covenants and restrictions, that the Company comply with
certain financial covenants, including a limitation on capital expenditures, a
minimum fixed charge coverage ratio, a minimum consolidated net worth, maximum
leverage and senior leverage ratios. The senior credit facility is
collateralized by substantially all of the Companys assets. 6




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The amended and restated subordinated term loan increased the Companys
$12 million subordinated term loan with an additional advance of $3 million,
which did not fund until October 2004. The Company has capitalized $0.3
million of deferred loan costs in connection with the amended and restated
subordinated term loan. The subordinated term loan bears interest at a fixed
rate of 10% per annum and matures on September 30, 2008. The subordinated
term loan provides, among other restrictions, that the Company comply with
certain financial covenants, including a limitation on capital expenditures, a
minimum fixed charge coverage ratio, a minimum consolidated net worth, maximum
leverage and senior leverage ratios. Also, the Company is not permitted to
make principal payments on the subordinated term loan while the senior credit
facility is outstanding. The subordinated term loan is collateralized by a
second lien on substantially all of the Companys assets. 6. NEWLY ISSUED ACCOUNTING STANDARDS In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46, Consolidation of Variable Interest Entities (FIN
46). FIN 46 requires unconsolidated variable interest entities to be
consolidated by their primary beneficiaries if the entities do not effectively
disperse the risks and rewards of ownership among their owners and other
parties involved. The provisions of FIN 46 are applicable immediately to all
variable interest entities created after January 31, 2003 and require certain
disclosures for all variable interest entities. In December 2003, the FASB
published a revision to FIN 46 (FIN 46R) to clarify some of the provisions of
the interpretation and to defer the effective date of implementation for
certain entities created before January 31, 2003. Under the guidance of FIN
46R, entities that do not have interests in structures that are commonly
referred to as special purpose entities (SPEs) are required to apply the
provisions of the interpretation in financial statements for periods ending
after March 14, 2004. The adoption of the provisions applicable to SPEs and
all other variable interests obtained after January 31, 2003 did not have an
impact on the Companys consolidated financial statements. As of September 30,
2004, the Company had no variable interest entities and there was no effect on
its consolidated balance sheet, statement of operations, and cash flows. 7. EARNINGS (LOSS) PER SHARE Basic net income (loss) per common share is computed by dividing net
income (loss) by the weighted average number of common shares outstanding
during the period. Diluted net income (loss) per common share is the same as
basic but includes dilutive stock options and warrants using the treasury stock
method. The following tables reconcile the numerators and denominators of the
basic and diluted per common share computations for net income (loss) for the
three and nine months ended September 30, 2004 and 2003, as follows (in
thousands except per share data): Three Months EndedSeptember 30,2004
    
    2003Numerator:Income from continuing operations
    
    $
    1,293
    
    
    $
    373Loss from discontinued operations
    
    
    (164
    )
    
    
    (257
    )Net income
    
    $
    1,129
    
    
    $
    116Denominator:Weighted average common shares outstanding  basic
    
    
    10,582
    
    
    
    10,582Shares for dilutive stock options
    
    
    
    
    
    
    Weighted average common shares outstanding and
Assumed conversions  diluted
    
    
    10,582
    
    
    
    10,582Basic earnings (loss) per common share:Continuing operations
    
    $
    .12
    
    
    $
    .04Discontinued operations
    
    
    (.01
    )
    
    
    (.03
    )Net income per common share
    
    $
    .11
    
    
    $
    .01
 7




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##### Table of Contents



Three Months EndedSeptember 30,2004
    
    2003Diluted earnings (loss) per common share:Continuing operations
    
    $
    .12
    
    
    $
    .04Discontinued operations
    
    
    (.01
    )
    
    
    (.03
    )Net income per common share
    
    $
    .11
    
    
    $
    .01
 For the three months ended September 30, 2004, there were 581,345 options
and 517,862 warrants that were not included in the computation of diluted
earnings per share because their inclusion would have been anti-dilutive. For
the three months ended September 30, 2003, there were 636,537 options and
517,862 warrants that were not included in the computation of diluted earnings
per share because their inclusion would have been anti-dilutive. Nine Months EndedSeptember 30,2004
    
    2003Numerator:Income from continuing operations
    
    $
    2,815
    
    
    $
    1,021Loss from discontinued operations
    
    
    (2,729
    )
    
    
    (463
    )Net income
    
    $
    86
    
    
    $
    558Denominator:Weighted average common shares outstanding  basic
    
    
    10,582
    
    
    
    10,582Shares for dilutive stock options
    
    
    2
    
    
    
    2Weighted average common shares outstanding and
Assumed conversions  diluted
    
    
    10,584
    
    
    
    10,584Basic earnings (loss) per common share:Continuing operations
    
    $
    .27
    
    
    $
    .10Discontinued operations
    
    
    (.26
    )
    
    
    (.05
    )Net income per common share
    
    $
    .01
    
    
    $
    .05Diluted earnings (loss) per common share:Continuing operations
    
    $
    .27
    
    
    $
    .10Discontinued operations
    
    
    (.26
    )
    
    
    (.05
    )Net income per common share
    
    $
    .01
    
    
    $
    .05
 For the nine months ended September 30, 2004, there were 481,345 options
and 517,862 warrants that were not included in the computation of diluted
earnings per share because their inclusion would have been anti-dilutive. For
the nine months ended September 30, 2003, there were 536,537 options and
517,862 warrants that were not included in the computation of diluted earnings
per share because their inclusion would have been anti-dilutive. 8. REPORTABLE SEGMENTS The Companys determination of reportable segments considers the strategic
operating units under which the Company sells various types of products and
services to various customers. The accounting policies of the segments are the same as those of the
Company. The Company evaluates performance based on income from operations
excluding certain corporate costs not allocated to the segments. Inter-segment
revenues are not material. Substantially all revenues are from domestic
sources and all assets are held in the United States. As discussed in Note 2,
the Company sold substantially all of the remaining assets of its Products
segment, except for certain assets related to the Companys custom coatings
business, and accordingly, their results of operations for 2004 and 2003 have
been reported as discontinued operations. In June 2004, the Company realigned
its operating segments due to the sale of substantially all of the assets of
its Products reporting segment. Since the Companys custom coatings business
is insignificant to the consolidated results of the Company and also has
similar economic characteristics, customers and products to the Pressure
Control reporting segment, the three historical reporting segments of Pressure
Control, Products and Distribution now operate under two reporting segments:
Pressure Control and Distribution. Accordingly, all historical 8




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##### Table of Contents



segment results reflect the new operating structure. Segment information for
the three and nine months ended September 30, 2004 and 2003 is as follows: (dollars in thousands)PressureControl
    
    Distribution
    
    Corporate
    
    ConsolidatedThree months ended September 30:2004Revenues
    
    $
    16,447
    
    
    $
    11,554
    
    
    $
    
    
    
    $
    28,001Depreciation and amortization
    
    
    368
    
    
    
    58
    
    
    
    189
    
    
    
    615Income (loss) from operations
    
    
    3,601
    
    
    
    610
    
    
    
    (1,411
    )
    
    
    2,800Capital expenditures
    
    
    690
    
    
    
    154
    
    
    
    47
    
    
    
    8912003Revenues
    
    $
    18,119
    
    
    $
    10,147
    
    
    $
    
    
    
    $
    28,266Depreciation and amortization
    
    
    527
    
    
    
    82
    
    
    
    185
    
    
    
    794Income (loss) from operations
    
    
    2,899
    
    
    
    573
    
    
    
    (1,649
    )
    
    
    1,823Capital expenditures
    
    
    252
    
    
    
    (12
    )
    
    
    62
    
    
    
    302
 (dollars in thousands)PressureControl
    
    Distribution
    
    Corporate
    
    ConsolidatedNine months ended September 30:2004Revenues
    
    $
    48,486
    
    
    $
    31,044
    
    
    $
    
    
    
    $
    79,530Depreciation and amortization
    
    
    1,138
    
    
    
    192
    
    
    
    556
    
    
    
    1,886Income (loss) from operations
    
    
    9,339
    
    
    
    1,594
    
    
    
    (4,373
    )
    
    
    6,560Capital expenditures
    
    
    1,050
    
    
    
    522
    
    
    
    317
    
    
    
    1,8892003Revenues
    
    $
    52,342
    
    
    $
    29,754
    
    
    $
    
    
    
    $
    82,096Depreciation and amortization
    
    
    1,509
    
    
    
    256
    
    
    
    531
    
    
    
    2,296Income (loss) from operations
    
    
    9,678
    
    
    
    1,543
    
    
    
    (5,182
    )
    
    
    6,039Capital expenditures
    
    
    486
    
    
    
    77
    
    
    
    475
    
    
    
    1,038
 9. CONTINGENCIES The Company is, from time to time, involved in various legal actions
arising in the normal course of business. In December 2001, a lawsuit was
filed against the Company in the 14th Judicial District Court of Calcasieu
Parish, Louisiana. The lawsuit alleges that certain equipment purchased from
and installed by a wholly owned subsidiary of the Company was defective in
assembly and installation. The plaintiffs have alleged certain damages in
excess of $5 million related to repairs and activities associated with the
product failure and have also claimed unspecified damages with respect to
certain expenses, loss of production and damage to the reservoir. The Company
has tendered the defense of this claim under its comprehensive general
liability insurance policy and its umbrella policy. Management does not
believe that the outcome of such legal actions involving the Company will have
a material adverse effect on the Companys financial position, results of
operations, or cash flows. The Companys environmental remediation and compliance costs have not been
material during any of the periods presented. T-3 has been identified as a
potentially responsible party with respect to one site designated for cleanup
under the Comprehensive Environmental Response Compensation and Liability Act
and similar state laws. The Companys involvement at this site is believed to
have been minimal. Because it is early in the process, no determination of the
Companys actual liability can be made at this time. As such, management has
not currently accrued for any future remediation costs related to this site.
However, based upon the Companys involvement with this site, management does
not expect that its share of remediation costs will have a material impact on
its financial position, results of operations and cash flows. In July 2001, the Company discovered preliminary information concerning
deep soil contamination at one of its leased facilities. This preliminary
information is limited, and the contamination source has not yet been
identified. The Company has informed the landlord of the existence of the
contamination and has requested that they remediate the property as required by
the lease. Management expects that the landlord will comply with its 9




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##### Table of Contents



obligations under the lease to investigate the environmental condition and take
any action required under applicable laws. Management does not believe that the
Company has contributed to or is responsible for remediation of the site. At September 30, 2004, the Company had no material letters of credit
outstanding. 10. SUBSEQUENT EVENTS On October 18, 2004, the Company completed the purchase of the Oilco Group
of Canada for approximately $10 million in cash subject to final adjustments.
The Oilco Group of Canada, which includes Oilco Equipment Ltd., Oilco
Enterprises Ltd., Alberta Rubber Products, Inc., and Oilco Services & Supply
Ltd. manufactures accumulators, re-manufactures blowout preventors, performs
field services on both accumulators and blowout preventors and manufactures
rubber goods used in the oilwell control industry. The acquisition was funded
from the Companys working capital and the use of its senior and subordinated
long term debt credit facilities. 10




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##### Table of Contents



ITEM 2.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS General The following discussion of our historical results of operations and
financial condition for the three and nine months ended September 30, 2004 and
2003 should be read in conjunction with the consolidated financial statements
and related notes included elsewhere in this Form 10-Q and our financial
statements and related managements discussion and analysis of financial
condition and results of operations for the year ended December 31, 2003
included in our Annual Report on Form 10-K. We have historically operated in three segments; however, during the
second quarter of 2004, the Company sold substantially all of the remaining
assets of its Products segment, except for certain assets related to the
Companys custom coatings business. Accordingly, the Products segments
results of operations for 2004 and 2003 have been reported as discontinued
operations. Due to the sale of substantially all of the assets of the Products
segment and since the Companys custom coatings business is insignificant to
the consolidated results of the Company and also has similar economic
characteristics, customers and products to the Pressure Control segment, the
Company realigned its operating segments during June 2004. The three
historical reporting segments of Pressure Control, Products and Distribution
now operate under two reporting segments: Pressure Control and Distribution.
Accordingly, all historical segment results reflect the new operating
structure. Our Pressure Control segment manufactures, remanufactures and
repairs high pressure, severe service products, including valves, chokes,
actuators, blowout preventers, manifolds and wellhead equipment and applies
custom coatings to customers products used primarily in the oil and gas
industry. Our Distribution segment engages in the specialty distribution of
pipes, valves, stud bolts, gaskets and other ancillary products. Our products
and services have historically been sold primarily to customers in the upstream
and downstream oil and gas industry located in the Texas and Louisiana Gulf
Coast region. The following table sets forth certain statistics that are reflective of
recent historical market conditions: WTI
    
    Henry Hub
    
    United States
    Gulf of MexicoQuarter Ended:
    
    Oil (1)
    
    Gas (2)
    
    Rig Count (3)
    Rig Count (4)March 31, 2003
    
    $
    34.10
    
    
    $
    5.91
    
    
    
    901
    
    
    
    104June 30, 2003
    
    $
    28.98
    
    
    $
    5.74
    
    
    
    1,028
    
    
    
    104September 30, 2003
    
    $
    30.21
    
    
    $
    4.89
    
    
    
    1,088
    
    
    
    105December 31, 2003.
    
    $
    31.18
    
    
    $
    5.45
    
    
    
    1,109
    
    
    
    102March 31, 2004
    
    $
    34.77
    
    
    $
    5.72
    
    
    
    1,121
    
    
    
    95June 30, 2004
    
    $
    38.32
    
    
    $
    6.15
    
    
    
    1,164
    
    
    
    92September 30, 2004
    
    $
    43.89
    
    
    $
    5.56
    
    
    
    1,229
    
    
    
    90
   (1)
    
    Source: Average price per barrel for the quarter calculated by us using
daily data published by the United States Department of Energy on its website,
www.eia.doe.gov.(2)
    
    Source: Average price per MM/BTU for the quarter calculated by us using
daily data published on www.oilnergy.com.(3)
    
    Source: Average United States Rig Count for the quarter calculated by us
using weekly data published by Baker Hughes Incorporated.(4)
    
    Source: Average Gulf of Mexico Rig Count for the quarter calculated by us
using weekly data published by Baker Hughes Incorporated. Demand for our products and services is cyclical and dependent upon
activity in the oil and gas industry and the profitability, cash flow and
willingness of oil and gas companies and drilling contractors to spend capital
on the exploration, development and production of oil and gas reserves in the
Gulf of Mexico and the United States Gulf Coast regions where our products and
services are primarily sold. The level of exploration and production, 11




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##### Table of Contents



our primary driver, especially in the Gulf of Mexico, is highly sensitive to
current and projected oil and natural gas prices, which have historically been
characterized by significant volatility. Over the last several years, the
United States drilling rig count has fluctuated due to world economic and
political trends that influence the supply and demand for energy, the price of
oil and natural gas and the level of exploration and drilling for those
commodities. The United States drilling rig count has increased steadily
throughout 2003 and 2004. However, the average Gulf of Mexico rig count
remained at relatively low levels throughout 2003 before a further decline
during 2004. Our revenue growth will continue to be heavily dependent upon the timing
and strength of the recovery in the Gulf of Mexico market and our gains in
market share outside the Gulf of Mexico. The extent of any recovery in the
Gulf of Mexico market and gains in market share outside the Gulf of Mexico are
not predictable. As illustrated in the table above, the market price of oil
and gas alone is not an indicator of a recovery in these markets. Many
external factors, including world economic and political conditions, quotas
established by OPEC (Organization of Petroleum Exporting Countries) and weather
conditions, will influence the recovery and continued strength of the industry.
Based on our assessment of external factors and our current levels of inquiry
and quotation, we believe that continuing price and general uncertainty in the
Gulf of Mexico market will cause near-term activity levels to remain flat for
the remainder of 2004. We expect that we will be able to maintain our market share in the Gulf of
Mexico and high-pressure gas markets. Because of the volatility of those
markets, key aspects of our strategy to build stockholder value include
expanding into international markets through agency agreements or acquisitions;
acquiring products and services that complement our existing Pressure Control
products and services in the manufacturing and aftermarket service arenas;
emphasizing inter-company coordination through bundled products and services,
combined sales efforts and inter-company purchases; completing strategic add-on
Pressure Control acquisitions both domestically and internationally; and
internally growing the Distribution segment domestically. By diversifying our
revenue base to lessen our dependence on the Gulf of Mexico market, and
expanding our products and services offered to both the domestic and
international onshore drilling and production markets, we will seek to enhance
our revenues and profitability. We have expanded into the Canadian market with
the acquisition of Oilco Group of Canada and expect to see the benefits of this
acquisition beginning in 2005. We have increased our Pressure Control
segments engineering and technical sales staff to improve our ability to
service our customers and have begun to introduce new high quality pressure
equipment in both the domestic and international onshore and offshore oil and
gas markets during the second half of 2004. We will seek to increase market
penetration and revenue increases beyond 2004 from these new products and
service capabilities. Critical Accounting Policies and Estimates The preparation of our financial statements requires us to make certain
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Our estimation process generally relates to
potential bad debts, obsolete and slow moving inventory, and the valuation of
long-lived and intangible assets. Our estimates are based on historical
experience and on our future expectations that we believe to be reasonable
under the circumstances. The combination of these factors results in the
amounts shown as carrying values of assets and liabilities in the financial
statements and accompanying notes. Actual results could differ from our current
estimates and those differences may be material. These estimates may change as events occur, as additional information is
obtained and as our operating environment changes. There have been no material
changes or developments in our evaluation of the accounting estimates and the
underlying assumptions or methodologies that we believe to be Critical
Accounting Policies and Estimates as disclosed in our Annual Report on Form
10-K for the year ending December 31, 2003. 12




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##### Table of Contents



Results of Operations The following table sets forth certain operating statement data for each
of our segments for each of the periods presented (in thousands).
Reclassifications have been made for discontinued operations to previously
reported amounts to make them consistent with current presentation format. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenues:Pressure Control
    
    $
    16,447
    
    
    $
    18,119
    
    
    $
    48,486
    
    
    $
    52,342Distribution
    
    
    11,554
    
    
    
    10,147
    
    
    
    31,044
    
    
    
    29,75428,001
    
    
    
    28,266
    
    
    
    79,530
    
    
    
    82,096Cost of revenues:Pressure Control
    
    
    10,457
    
    
    
    12,629
    
    
    
    31,795
    
    
    
    35,197Distribution
    
    
    8,992
    
    
    
    7,464
    
    
    
    23,560
    
    
    
    21,88619,449
    
    
    
    20,093
    
    
    
    55,355
    
    
    
    57,083Gross profit:Pressure Control
    
    
    5,990
    
    
    
    5,490
    
    
    
    16,691
    
    
    
    17,145Distribution
    
    
    2,562
    
    
    
    2,683
    
    
    
    7,484
    
    
    
    7,8688,552
    
    
    
    8,173
    
    
    
    24,175
    
    
    
    25,013Selling, general and administrative expenses:Pressure Control
    
    
    2,389
    
    
    
    2,591
    
    
    
    7,352
    
    
    
    7,467Distribution
    
    
    1,952
    
    
    
    2,110
    
    
    
    5,890
    
    
    
    6,325Corporate
    
    
    1,411
    
    
    
    1,649
    
    
    
    4,373
    
    
    
    5,1825,752
    
    
    
    6,350
    
    
    
    17,615
    
    
    
    18,974Income (loss) from operations:Pressure Control
    
    
    3,601
    
    
    
    2,899
    
    
    
    9,339
    
    
    
    9,678Distribution
    
    
    610
    
    
    
    573
    
    
    
    1,594
    
    
    
    1,543Corporate
    
    
    (1,411
    )
    
    
    (1,649
    )
    
    
    (4,373
    )
    
    
    (5,182
    )$
    2,800
    
    
    $
    1,823
    
    
    $
    6,560
    
    
    $
    6,039
 Three Months ended September 30, 2004 Compared with Three Months ended
September 30, 2003 Revenues.On a consolidated basis, revenues decreased $0.3 million, or
0.9%, in 2004 compared to 2003. This decrease was primarily attributable to the
continued softness in the Gulf of Mexico drilling activity and continued
pricing pressure for substantially all our products and services. This
decrease was partially offset by increased revenues from certain Pressure
Control products and services resulting from an improved United States onshore
rig count, and increased pipe and valve distribution sales. Revenues for the Pressure Control segment decreased $1.7 million, or 9.2%,
in 2004 compared to 2003. The decrease was primarily attributable to the
continued softness in the Gulf of Mexico drilling rig activity and continued
pricing pressure for substantially all of our products and services. This
decrease was partially offset by increased revenues resulting from an improved
United States onshore rig count. Revenues for the Distribution segment increased $1.4 million, or 13.9%, in
2004 compared to 2003 due to increased pipe and valve distribution sales. Cost of Revenues.On a consolidated basis, cost of revenues decreased $0.6
million, or 3.2%, in 2004 compared to 2003 as a result of the decrease in
pressure control revenues described above. Gross profit as a percentage of
revenues was 30.5% in 2004 compared to 28.9% in 2003. Gross profit margin was
higher on a consolidated basis in 2004 due to cost reduction strategies,
including lower self-insured medical costs, and slightly improved margins from our onshore products and services. This
increase was partially offset by continued pricing pressure in both segments. 13




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Cost of revenues for the Pressure Control segment decreased $2.2 million,
or 17.2%, in 2004 compared to 2003. The decrease is primarily a result of the
decrease in revenues described above. Gross profit as a percentage of revenues
was 36.4% in 2004 compared to 30.3% in 2003. Gross profit margin was higher in
2004 due to cost reduction strategies, including lower self-insured medical
costs, and slightly improved margins from our onshore products and services.
This was partially offset by continued pricing pressure. Cost of revenues for the Distribution segment increased $1.6 million, or
20.5%, in 2004 compared to 2003, primarily due to the increase in revenues in
2004. Gross profit as a percentage of revenues was 22.2% in 2004 compared to
26.4% in 2003. Gross profit margin was lower in 2004 due to continued pricing
pressure and the volume and mix of pipe and valve sales. Operating expenses.On a consolidated basis, operating expenses decreased
$0.6 million, or 9.4%, in 2004 compared to 2003. Operating expenses as a
percentage of revenues was 20.5% in 2004 compared to 22.5% in 2003. This
decrease was due to cost reduction strategies, including lower self-insured
medical costs, lower general insurance costs and headcount reductions. Operating expenses for the Pressure Control segment decreased $0.2
million, or 7.8%, in 2004 compared to 2003. Operating expenses as a percentage
of revenues were 14.5% in 2004 compared to 14.3% in 2003. The decrease was
primarily a result of lower self-insured medical costs. Operating expenses for the Distribution segment decreased $0.2 million, or
7.5%, in 2004 compared to 2003. As a percentage of revenues, operating
expenses decreased from 20.8% in 2003 to 16.9% in 2004, primarily because as
revenues increased, operating expenses did not increase proportionally in
addition to decreased costs due to cost reduction strategies such as lower
self-insured medical costs. Operating expenses for Corporate operations decreased $0.2 million, or
14.4%, in 2004 compared to 2003. This was primarily attributable to cost
reduction strategies and headcount reductions. Interest Income.Interest income primarily was generated from seller
notes receivable that arose in conjunction with the sale by Industrial
Holdings, Inc. of several business units in 2001. Income Taxes.Income tax expense for 2004 was $0.9 million as compared to
$0.3 million in 2003. The effective tax rate was 41% in 2004 compared to 47%
in 2003, resulting from the effect of non-deductible expenses and state income
taxes, net of the Federal benefit provided. Income from Continuing Operations.On a consolidated basis, net income
from continuing operations was $1.3 million in 2004 compared with $0.4 million
in 2003 as a result of the foregoing factors. Discontinued operations.During the fourth quarter of 2003, we committed
to a formal plan to sell certain non-core assets within our Products segment,
primarily certain assets of LSS  Lone Star  Houston Inc., Bolt Manufacturing
Co., Inc. and WHIR Acquisition, Inc. The sale of these assets was consummated
in February 2004. During the second quarter of 2004, we continued to focus
more on our business strategy as it related to the Pressure Control segment and
received inquiries for substantially all of the remaining assets within our
Products segment, primarily Moores Machine Shop, TPS, and Moores Pump.
Accordingly, we committed to formal plans to sell these remaining assets within
our Products segment, along with certain assets within our Pressure Control
segment, primarily CPL. The sales of the Moores Machine Shop and TPS assets
were consummated during May and June 2004, respectively, and the assets of
Moores Pump and CPL were sold during the third quarter of 2004. These assets
constitute businesses and their results of operations were reported in
discontinued operations in 2003 and 2004 in accordance with SFAS No. 144. 14




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Nine Months ended September 30, 2004 Compared with Nine Months ended September
30, 2003 Revenues.On a consolidated basis, revenues decreased $2.6 million, or
3.1%, in 2004 compared to 2003. Although United States drilling activity
increased from period to period and oil and natural gas prices increased, the
continued softness in the Gulf of Mexico rig count and increased pricing
pressure in our Pressure Control segment were the major causes of the decline
in our revenues. This decrease was partially offset by increased revenues from
certain Pressure Control products and services resulting from an improved
United States onshore rig count, and increased pipe and valve distribution
sales. Revenues for the Pressure Control segment decreased $3.9 million, or 7.4%,
in 2004 compared to 2003. The decrease was primarily attributable to the
continued softness in the Gulf of Mexico drilling rig activity and continued
pricing pressure for substantially all of our products and services. This
decrease was partially offset by increased revenues resulting from an improved
United States onshore rig count. Revenues for the Distribution segment increased $1.3 million, or 4.3%, in
2004 compared to 2003 due to increased pipe and valve distribution sales. Cost of Revenues.On a consolidated basis, cost of revenues decreased $1.7
million, or 3.0%, in 2004 compared to 2003 as a result of the decrease in
revenues described above. Gross profit as a percentage of revenues was 30.4% in
2004 compared to 30.5% in 2003. Gross profit margin was slightly lower on a
consolidated basis in 2004 because of continued pricing pressure, offset by
cost reduction strategies, including lower self-insured medical costs. Cost of revenues for the Pressure Control segment decreased $3.4 million,
or 9.7%, in 2004 compared to 2003. The decrease was primarily a result of the
decrease in revenues described above. Gross profit as a percentage of revenues
was 34.4% in 2004 compared to 32.8% in 2003. Gross profit margin was higher
during 2004 due to cost reduction strategies, including lower self-insured
medical costs and slightly improved margins from some of our products and
services resulting from an improved United States onshore rig count. This was
partially offset by continued pricing pressure. Cost of revenues for the Distribution segment increased $1.7 million, or
7.6%, in 2004 compared to 2003. Gross profit as a percentage of revenues was
24.1% in 2004 compared to 26.4% in 2003. Gross profit margin was lower in 2004
due to continued pricing pressure and the volume and mix of pipe and valve
sales. Operating expenses.On a consolidated basis, operating expenses decreased
$1.3 million, or 7.2%, in 2004 compared to 2003. Operating expenses as a
percentage of revenues was 22.1% in 2004 compared to 23.1% in 2003. Operating
expenses decreased due to cost reduction strategies, including lower
self-insured medical costs and headcount reductions offset by expenses
associated with the improvement of the Pressure Control segments engineering
and technical sales support division. Operating expenses for the Pressure Control segment decreased $0.1
million, or 1.5%, in 2004 compared to 2003. Operating expenses as a percentage
of revenues were 15.2% in 2004 compared to 14.3% in 2003. The decrease was
primarily a result of lower self-insured medical costs, offset by the
write-down of other intangible assets associated with the disposition of
certain spray welding assets and additional expenses associated with the
improvement of our engineering and technical sales support division. Operating expenses for the Distribution segment decreased $0.4 million, or
6.9%, in 2004 compared to 2003. As a percentage of revenues, operating
expenses decreased from 21.3% in 2003 to 19.0% in 2004, primarily due to cost
reduction strategies, including lower self-insured medical costs, offset
partially by costs associated with the expansion of the Distribution segment. Operating expenses for Corporate operations decreased $0.8 million, or
15.6%, in 2004 compared to 2003. This was primarily attributable to cost
reduction strategies and headcount reductions. Interest Income.Interest income was primarily generated from seller
notes receivable that arose in conjunction with the sale by Industrial Holdings, Inc. of several business
units in 2001. 15




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Write-down of Acquired Note Receivable.In the first quarter of 2003, we
wrote down a note receivable that was acquired in conjunction with the disposal
by Industrial Holdings, Inc. of Beaird Industries, Inc. (Beaird) prior to the
completion of its merger with us. During the first quarter of 2003, we were
informed by Beaird of its inability to make timely payments and that its
ongoing refinancing efforts to date had been unsuccessful. A reserve of
approximately 50% of the note was recorded because we believed at that time
that the notes net realizable value was approximately $1.7 million at March
31, 2003. This note was fully written off in the fourth quarter of 2003
because of Beairds failed refinancing efforts and the unlikelihood of any
future collections. Income Taxes.Income tax expense for 2004 was $1.9 million as compared to
$0.8 million in 2003. The effective tax rate was 40% in 2004 compared to 43%
in 2003, resulting from the effect of non-deductible expenses and state income
taxes, net of the Federal benefit provided. Income from Continuing Operations.On a consolidated basis, net income
from continuing operations was $2.8 million in 2004 compared with $1.0 million
in 2003 as a result of the foregoing factors. Discontinued operations.During the fourth quarter of 2003, we committed
to a formal plan to sell certain non-core assets within our Products segment,
primarily certain assets of LSS  Lone Star  Houston Inc., Bolt Manufacturing
Co., Inc. and WHIR Acquisition, Inc. The sale of these assets was consummated
in February 2004. During the second quarter of 2004, we continued to focus
more on our business strategy as it related to the Pressure Control segment and
received inquiries for substantially all of the remaining assets within our
Products segment, primarily Moores Machine Shop, TPS, and Moores Pump.
Accordingly, we committed to formal plans to sell these remaining assets within
our Products segment, along with certain assets within our Pressure Control
segment, primarily CPL. The sales of the Moores Machine Shop and TPS assets
were consummated during May and June 2004, respectively, and the assets of
Moores Pump and CPL were sold during the third quarter of 2004. During the
second quarter of 2004, we recorded a loss of $2.9 million for the above
dispositions. Included in this loss was a goodwill impairment charge of $0.3
million, a $0.2 million charge to other intangible assets and a $2.4 million
charge to tangible assets. These assets constitute businesses and their
results of operations were reported in discontinued operations in 2003 and 2004
in accordance with SFAS No. 144. Liquidity and Capital Resources At September 30, 2004, we had working capital of $29.3 million, current
maturities of long-term debt of $0.04 million, long-term debt of $12.0 million
and stockholders equity of $102.5 million. Historically, our principal
liquidity requirements and uses of cash have been for debt service, capital
expenditures, working capital and acquisition financing, and our principal
sources of liquidity and cash have been from cash flows from operations,
borrowings under long-term debt arrangements and issuances of equity
securities. We have historically financed acquisitions through bank borrowings,
sales of equity (primarily to affiliates of First Reserve Corporation) and
internally generated funds. Net Cash Provided by Operating Activities.For the nine months ended
September 30, 2004, net cash provided by operating activities was $5.2 million
compared to $5.1 million provided in the same period in 2003. Cash provided by
operations increased slightly in 2004 as compared to 2003 because of decreased
payments on accounts payable and increased collections of accounts receivable,
offset by increases in certain inventories to take advantage of favorable
pricing and expansion of the Distribution segment. Net Cash Used in Investing Activities.Principal uses of cash are for
capital expenditures and acquisitions. Investing activities used cash of $0.9
million in the nine months ended September 30, 2004 compared to $1.0 million in
the same period in 2003. For the nine months ended September 30, 2004 and 2003,
we made capital expenditures of approximately $1.9 million and $1.0 million,
respectively. Net Cash Used in Financing Activities.Sources of cash from financing
activities include borrowings under credit facilities and sales of equity
securities. Financing activities used net cash of $12.6 million in the nine 16




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months ended September 30, 2004 compared to $4.3 million used in the same
period in 2003. During 2004, we made principal payments of $12.3 million on
our long-term debt, exclusive of our revolving credit facility, compared to
$4.1 million in 2003. Net Cash Provided by (Used In) Discontinued Operations.For the nine
months ended September 30, 2004, net cash provided by discontinued operations
was $10.2 million compared to $0.7 million used in the same period in 2003.
Cash was provided by discontinued operations in 2004 primarily due to our
receipt of $7.4 million in cash in February 2004, $1.0 million in cash in May
2004, $0.4 million in cash in June 2004 and $1.1 million in cash in July 2004
upon the sales of assets of these operations. Principal Debt Instruments.As of September 30, 2004, we had an aggregate
of $12.1 million borrowed under our senior credit facility and debt instruments
entered into or assumed in connection with acquisitions, as well as other bank
financings. As of September 30, 2004, as a result of the lesser of the
leverage ratio covenant and the senior leverage ratio covenant, as defined in
the credit agreement for our senior credit facility, our availability under our
revolving credit facility was limited to $34.1 million. On September 30, 2004, we amended and restated our senior credit facility
and subordinated term loan. The amended and restated senior credit facility
provides for a $50 million revolving line of credit that we can increase by up
to $25 million (not to exceed a total commitment of $75 million) and matures
September 30, 2007. The senior credit facility consists of a revolving credit
facility that includes a swing line subfacility up to $5 million and a letter
of credit subfacility up to $5 million. We have capitalized $0.4 million of
deferred loan costs in connection with the amended and restated senior credit
facility. We will use the proceeds from any advances made pursuant to the
senior credit facility to refinance indebtedness, for working capital purposes,
capital expenditures, and to fund acquisitions. The applicable interest rate
of the senior credit facility is governed by our leverage ratio and ranges from
prime plus 0.75% or LIBOR plus 1.75% to prime plus 2.00% or LIBOR plus 3.00%.
We are required to prepay the senior credit facility under certain
circumstances with the net cash proceeds of certain asset sales, insurance
proceeds and equity issuances subject to certain conditions. The senior credit
facility provides, among other covenants and restrictions, that we comply with
certain financial covenants, including a limitation on capital expenditures, a
minimum fixed charge coverage ratio, a minimum consolidated net worth, maximum
leverage and senior leverage ratios. The senior credit facility is
collateralized by substantially all of our assets. The amended and restated subordinated term loan increased our $12 million
subordinated term loan with an additional advance of $3 million, which did not
fund until October 2004. We have capitalized $0.3 million of deferred loan
costs in connection with the amended and restated subordinated term loan. The
subordinated term loan bears interest at a fixed rate of 10% per annum and
matures on September 30, 2008. The subordinated term loan provides, among
other restrictions, that we comply with certain financial covenants, including
a limitation on capital expenditures, a minimum fixed charge coverage ratio, a
minimum consolidated net worth, maximum leverage and senior leverage ratios.
Also, we are not permitted to make principal payments on the subordinated term
loan while the senior credit facility is outstanding. The subordinated term
loan is collateralized by a second lien on substantially all of our assets. Prior to the amended and restated senior credit facility, on December 17,
2001, we entered into a senior credit facility with Wells Fargo, N.A. and
General Electric Capital Corporation maturing December 17, 2004. Concurrently,
we entered into a $12.0 million subordinated term loan with Wells Fargo Energy
Capital, Inc. maturing December 17, 2005. The senior credit facility included
a revolving credit facility of the lesser of a defined borrowing base (based
upon 85% of eligible accounts receivable and 50% of eligible inventory) or
$25.0 million, a term loan of $16.5 million and an optional facility for up to
an additional $30.0 million in the form of a revolving credit commitment for
future acquisitions based upon specific criteria. The senior credit facilitys
term loan was payable in equal quarterly installments of $0.8 million. The
applicable interest rate of the senior credit facility was governed by our
trailing-twelve-month funded debt-to-EBITDA ratio and ranged from prime plus
1.25% or LIBOR plus 2.25% to prime plus 2.00% or LIBOR plus 3.00%. At
September 30, 2004, the senior credit facility bore interest at prime plus
1.75%, with interest payable quarterly. 17




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The subordinated term loan bore interest at a fixed rate of 9.50% with
interest payable quarterly. The principal balance was due in full on December
17, 2005. The effective interest rate, including amortization of loan costs,
was 10.66%. We believe that cash generated from operations and amounts available under
our amended and restated senior credit facility and from other sources of debt
will be sufficient to fund existing operations, working capital needs, capital
expenditure requirements and financing obligations. We also believe any
significant increase in capital expenditures caused by any need to increase
manufacturing capacity can be funded from operations or through debt financing. We intend to pursue additional acquisition candidates, but the timing,
size or success of any acquisition effort and the related potential capital
commitments cannot be predicted. We expect to fund future cash acquisitions
primarily with cash flow from operations and borrowings, including the
unborrowed portion of our senior credit facility or new debt issuances, but may
also issue additional equity either directly or in connection with an
acquisition. However, there can be no assurance that acquisition funds may be
available at terms acceptable to us. A summary of our outstanding contractual obligations and other commercial
commitments at September 30, 2004 is as follows (in thousands): Payments Due by PeriodContractual Obligations
    
    Total
    
    Less than 1 Year
    
    1-3 Years
    
    4-5 Years
    
    After 5 YearsLong-term debt
    
    $
    12,090
    
    
    $
    43
    
    
    $
    47
    
    
    $
    12,000
    
    
    $
    Operating leases
    
    
    4,106
    
    
    
    1,176
    
    
    
    2,332
    
    
    
    300
    
    
    
    298Total contractual obligations
    
    $
    16,196
    
    
    $
    1,219
    
    
    $
    2,379
    
    
    $
    12,300
    
    
    $
    298
 Forward-Looking Information and Risk Factors Certain information in this Quarterly Report on Form 10-Q includes
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can
identify these forward-looking statements by the words expects, projects,
believes, anticipates, intends, plans, budgets, predicts,
estimates and similar expressions. We have based the forward-looking statements relating to our operations on
our current expectations, and estimates and projections about us and about the
industries in which we operate in general. These statements are not guarantees
of future performance and involve risks, uncertainties and assumptions. In
addition, many of these forward-looking statements are based on assumptions
about future events that may prove to be inaccurate. Actual outcomes and
results may differ materially from what we have expressed or forecast in the
forward-looking statements. Because we depend on the oil and gas industry, a decline in oil and gas prices
or a decrease in industry activity will negatively impact our profits. We are, and will continue to be, dependent upon the oil and gas industry
and the level of oil and gas exploration and production. The level of
exploration and production depends upon the prevailing view of future product
prices. Many factors affect the supply and demand for oil and gas and therefore
influence product prices, including:  
    
    the level of production from known reserves;
    
    weather conditions;
    
    the actions of the Organization of Petroleum Exporting Countries; 18




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
    
    political instability in the Middle East and elsewhere;
    
    the level of oil and gas inventories;
    
    the cost of producing oil and gas;
    
    the level of drilling activity;
    
    worldwide economic activity; and
    
    governmental regulation. If there is a significant reduction in the demand for drilling services,
cash flows of drilling contractors or production companies or drilling or well
servicing rig utilization rates, then demand for our products will decline. The oilfield service industry in which we operate is highly competitive, which
may result in a loss of market share or a decrease in revenue or profit
margins. The oilfield service industry in which we operate is highly competitive.
Many of our competitors have greater financial and other resources than we do.
Each of our operating units is subject to competition from a number of
similarly sized or larger businesses. Factors that affect competition include
price, quality and customer service. Strong competition may result in a loss of
market share and a decrease in revenue and profit margins. Our success will be
affected by our ability to lower our cost structure. Our forward-looking
statements in this regard assume we will be successful in reducing our cost
structure and adapting to the changing environment. Availability of a skilled workforce could affect our projected results. The workforce and labor supply in the oilfield service industry is aging
and diminishing such that there is an increasing shortage of available skilled
labor. Our forward-looking statements in this regard assume we will be able to
maintain a skilled workforce. Our long-term growth depends upon technological innovation and
commercialization. Our ability to deliver our long-term growth strategy depends in part on
the commercialization of new technology. A central aspect of our growth
strategy is to innovate our products and services, to obtain technologically
advanced products through internal research and development and/or
acquisitions, and to expand internationally. The key to our success will be our
ability to commercialize the technology that we have acquired and demonstrate
the enhanced value our technology brings to our customers operations. Our
forward-looking statements in this regard have assumed successful
commercialization of, and above-average growth from, these new products and
services. The cyclical nature of or a prolonged downturn in our industry could affect the
carrying value of our goodwill. During 2003 and the second quarter of 2004, we had goodwill impairments
related to continuing and discontinued operations totaling $26.4 million and
$0.3 million, respectively. As of September 30, 2004, we had approximately
$68.1 million of goodwill after the aforementioned impairments. Our estimates
of the value of our goodwill could be reduced in the future as a result of
various factors, some of which are beyond our control. Any reduction in the
value of our businesses may result in further impairment charges and therefore
adversely affect our results. 19




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A rise in insurance premiums could adversely impact our results and affect our
ability to adequately insure for certain contingent liabilities. We maintain insurance to cover potential claims and losses, including
claims for personal injury or death resulting from the use of our products. We
carry comprehensive insurance, subject to deductibles, at levels we believe are
sufficient to cover existing and future claims. The terrorist attacks that
occurred in the U.S., as well as other factors, have generally increased the
cost of insurance for companies, including ours. Significant increases in the
cost of insurance and more restrictive coverage may adversely impact our
results of operations. In addition, we may not be able to maintain adequate
insurance coverage at rates we believe are reasonable. Uninsured or underinsured claims and litigation could adversely impact our
results. In the ordinary course of business, we become the subject of various
claims and litigation. We maintain insurance to cover many of our potential
losses and we are subject to various self-retentions and deductibles with
respect to our insurance. Although we are subject to various ongoing items of
litigation, we do not believe any of the items of litigation we are currently
subject to will result in any material uninsured or underinsured losses.
However, it is possible an unexpected judgment could be rendered against us in
cases in which we could be uninsured or underinsured and beyond the amounts we
currently have reserved or anticipate incurring. Our operations are subject to regulation by federal, state and local
governmental authorities that may limit our ability to operate our business. Our business is affected by governmental regulations relating to our
industry segments in general, as well as environmental and safety regulations
that have specific application to our business. While we are not aware of any
proposed or pending legislation, future legislation may have an adverse effect
on our business, financial condition, results of operations or prospects. We are subject to various federal, state and local environmental laws,
including those governing air emissions, water discharges and the storage,
handling, disposal and remediation of petroleum and hazardous substances. We
have in the past and will likely in the future incur expenditures to ensure
compliance with environmental laws. Due to the possibility of unanticipated
factual or regulatory developments, the amount and timing of future
environmental expenditures could vary substantially from those currently
anticipated. Moreover, certain of our facilities have been in operation for
many years and, over that time, we and other predecessor operators have
generated and disposed of wastes that are or may be considered hazardous.
Accordingly, although we have undertaken considerable efforts to comply with
applicable laws, it is possible that environmental requirements or facts not
currently known to us will require unanticipated efforts and expenditures that
cannot be currently quantified. Two of our directors may have conflicts of interest because they are also
directors or officers of First Reserve Corporation. The resolution of these
conflicts of interest may not be in our or our stockholders best interests. Two of our directors, Joseph R. Edwards and Ben A. Guill, are also current
officers or employees of First Reserve Corporation, which controls the general
partner of First Reserve Fund VIII, L.P. This may create conflicts of interest
because these directors have responsibilities to First Reserve Fund VIII and
its owners. Their duties as directors or officers of First Reserve Corporation
may conflict with their duties as directors of the Company regarding business
dealings between First Reserve Corporation and the Company and other matters.
The resolution of these conflicts may not always be in our or our stockholders
best interests. We will renounce any interest in specified business opportunities, and First
Reserve Fund VIII and its director designees on our board of directors
generally will have no obligation to offer us those opportunities. First Reserve Fund VIII has investments in other oilfield service
companies that compete with the Company, and First Reserve Corporation and its
affiliates, other than T-3, may invest in other such companies in the future. 20




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We refer to First Reserve Corporation, its other affiliates and its portfolio
companies as the First Reserve group. Our certificate of incorporation
provides that, so long as First Reserve Corporation and its affiliates continue
to own at least 20% of the Companys common stock, we renounce any interest in
specified business opportunities. Our certificate of incorporation also
provides that if an opportunity in the oilfield services industry is presented
to a person who is a member of the First Reserve group, including any
individual who also serves as First Reserve Fund VIIIs director designee of
the Company:  
    
    no member of the First Reserve group or any of those individuals
will have any obligation to communicate or offer the opportunity to the
Company; and
    
    such entity or individual may pursue the opportunity as that entity
or individual sees fit, unless:  
    
    it was presented to a member of the First Reserve group in that
persons capacity as a director or officer of T-3; or
    
    the opportunity was identified solely through the disclosure of
information by or on behalf of T-3. These provisions of our certificate of incorporation may be amended only by an
affirmative vote of holders of at least 80% of its outstanding common stock.
As a result of these charter provisions, our future competitive position and
growth potential could be adversely affected. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS Market risk generally represents the risk that losses may occur in the
value of financial instruments as a result of movements in interest rates,
foreign currency exchange rates and commodity prices. We are exposed to some market risk due to the floating interest rate under
our amended and restated revolving credit facility and certain of our term
debt. Our revolving credit facility has an interest rate that floats with
prime or LIBOR. As of September 30, 2004, our revolving credit facility had no
principal balance. Thus, a 1.0% increase in interest rates would not result in
an increase in interest expense based on the existing principal balance. 
 ITEM 4. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures As of the end of the period covered by this report, our management carried
out an evaluation, with the participation of our principal executive officer
(the CEO) and our principal financial officer (the Corporate Controller),
of the effectiveness of our disclosure controls and procedures pursuant to Rule
13a-15 of the Securities and Exchange Act of 1934. Based on those evaluations,
the CEO and Corporate Controller believe:  i.
    
    that our disclosure controls and procedures are designed to ensure
that information required to be disclosed by us in the reports that we
file or submit under the Securities and Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods
specified in the SECs rules and forms, and that such information is
accumulated and communicated to our management, including the CEO and
Corporate Controller, as appropriate to allow timely decisions
regarding required disclosure; andii.
    
    that our disclosure controls and procedures are effective. Changes in Internal Controls Over Financial Reporting There have been no significant changes in our internal controls over
financial reporting during the period covered by this report that has
materially affected, or are reasonably likely to materially affect, our control
over financial reporting. 21




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PART II 
 Item 1. Legal Proceedings The Company is involved in various claims and litigation arising in the
ordinary course of business. In December 2001, a lawsuit was filed against the
Company in the 14th Judicial District Court of Calcasieu Parish, Louisiana as
Aspect Energy LLC v. United Wellhead Services, Inc. The lawsuit alleges that
certain equipment purchased from and installed by United Wellhead Services,
Inc., a wholly owned subsidiary of the Company, was defective in assembly and
installation. The plaintiffs have alleged certain damages in excess of $5
million related to repairs and activities associated with the product failure
and have also claimed unspecified damages with respect to certain expenses,
loss of production and damage to the reservoir. The Company has tendered the
defense of this claim under its comprehensive general liability insurance
policy and its umbrella policy. The Company does not believe that the outcome
of such legal actions involving the Company will have a material adverse effect
on the Companys consolidated financial condition or results of operations. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None 
 Item 3. Defaults Upon Senior Securities None 
 Item 4. Submission of Matters to a Vote of Security Holders None 
 Item 5. Other Information None 
 Item 6. Exhibits ExhibitNumber
    
    Identification of Exhibit31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
or Rule 15d-14(a), promulgated under the Securities Exchange Act of
1934, as amended31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
or Rule 15d-14(a), promulgated under the Securities Exchange Act of
1934, as amended32.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant
To Section 906 Of The Sarbanes-Oxley Act Of 2002 (Chief Executive
Officer)32.2
    
    Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant
To Section 906 Of The Sarbanes-Oxley Act Of 2002 (Chief Financial
Officer)
 22




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SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on the 3rd day of
November 2004. T-3 ENERGY SERVICES, INC.By:
    /s/ MICHAEL T. MINOMichael T. Mino (CorporateController and Vice President) 23




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INDEX TO EXHIBITS ExhibitNumber
    
    Identification of Exhibit31.1*
    
    Certification of Chief Executive Officer pursuant to Rule
13a-14(a) or Rule 15d-14(a), promulgated under the Securities
Exchange Act of 1934, as amended31.2*
    
    Certification of Chief Financial Officer pursuant to Rule
13a-14(a) or Rule 15d-14(a), promulgated under the Securities
Exchange Act of 1934, as amended32.1*
    
    Certification Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002 (Chief
Executive Officer)32.2*
    
    Certification Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002 (Chief
Financial Officer)
   *
    
    Filed herewith.